Update August 2015

Cruel Summer
What Happened? Why?
The recent erosion in equities turned into an all-out landslide last week
and continued into Monday. The Dow Jones Industrial Average lost
more than 1,000 points last week, its biggest weekly pullback since
September 2011, and added more than 410 points to those losses on
Monday. Stocks have been under pressure for some time, and it
appears that investors finally gave in.
Several factors have driven the sharp sell-off:
1. Further evidence of economic weakness in China and the
devaluation of the Yuan
2. Generally slowing global economic growth along with commodity
price weakness and deflationary concerns
3. Uncertainty over Federal Reserve policy as it relates to interest
rates
4. Increased investor nervousness and uncertainty caused by all of
the above
Has the Economic and Market Backdrop Deteriorated?
Investor sentiment may have taken a hit and will take some time to
recover. This may have some near-term negative implications, but
odds are the global economy (and the U.S. economy in particular)
remains sound. Investors have become increasingly concerned about
growth prospects and deflationary trends, with the sharp downturn in
oil and commodities being at the epicenter of these worries. The
abnormally slow and choppy recovery has also acted as a drag on
sentiment over the past few years. Moreover, many are worried that it
is a mistake for the Federal Reserve to raise rates.
We have seen multiple periods of intense but short-lived risk-off
phases since the end of the Great Recession and we may be in the
midst of another risk-off. Despite this, odds favor a relatively upbeat
global economic growth outlook. Many regions continue to struggle,
but forward indicators point to a moderate acceleration of U.S. growth
driven by higher levels of consumer spending and an improved
employment picture. Furthermore, lower energy prices are a net
positive for the U.S. economy and should act as a tailwind for corporate
earnings in the coming quarters. Increasing anxiety and the current
downturn may also be factors that could delay any Fed rate increases.
But when the Fed does act, a modest rate increase should prove to be
a near non-event since policy will continue to remain relatively
accommodative. Pessimism remains high, which will likely keep
markets unsettled. However, investors may look back on the present

time as similar to other periods of rockiness we have experienced since

this bull market began and like those other periods of volatility, this
might end being little more than a bump in the road during a period of
slow and uneven growth.

What Should We Expect from Here?

What will it take for financial markets to resume their uptrend? For one,
we need more consistent and clearer signs that economic growth is on
track and that corporate earnings have recovered. It is likely the global
economy will regain momentum, led by the United States and Europe,
and this will lead to better earnings growth in the coming quarters. In
addition, investors will require signs the Chinese economy is not
entering a free fall. Chinas economy is clearly in trouble, but it is also
likely policymakers will engage in additional easing measures to
promote growth. This should assuage fears that the country is facing a
hard economic landing. None of these factors is likely to emerge
quickly or easily, but they should eventually occur and help the
resulting recovery.
How Should Investors Position Themselves?
Pessimism is on the upswing and equity sentiment has soured as
witnessed by the recent market decline and heightened volatility. This
may not change quickly, but this period of time may, in retrospect, be
viewed as a juncture where prices of stocks have more than discounted
the increased sense of uncertainty which has pervaded the markets
over the past few weeks. While this may not mark the end of the bull
market which began in 2009, we should be able to see good growth
prospects, albeit at a more moderate pace and with higher levels of
market volatility as me move forward.

Amin Khakiani
August 24, 2015